Pitfalls of Debt Settlement and Consolidation

Dianne C. Kerns, Chapter 13 Trustee,  Southern Arizona


We’ve all heard the radio advertisements: “If you have more than $10,000 in credit card or tax debt, you may qualify for a new program that credit card companies don’t want you to know about.  Settle your debts for pennies on the dollar without filing bankruptcy.”

The truth is that there is no debt settlement program.  Credit card companies and the IRS have no obligation to settle your debts.  These advertisements come from profit motivated companies that appeal to your desperation when you’re struggling under the weight of debt. 

How does it work?  Usually, they instruct you to stop making your credit card payments and instead make payments to them.    When your accounts go into default, some creditors MAY eventually agree to charge off the loan after accepting less than the amount owed.  But they don’t have to, and they are free to continue hounding you until they do—they may even garnish your wages.  The process can take years and destroys whatever is left of your credit.  Sadly, much of the money you pay goes to the debt settlement company, even if your debts aren’t settled. 

Debt consolidation can be a slightly safer route because it usually doesn’t destroy your credit.  You substitute a single loan for several loans, without any reduction in the amount owed.  But it is only available if you have good enough credit to qualify for a new loan and it may not end up addressing the underlying issues at all.

So why do we try to deal with debt without filing for bankruptcy?  Maybe there is a bankruptcy stigma.  Maybe we think we’ll lose everything in bankruptcy.  Maybe we assume it shows a lack of character.  But, as a bankruptcy trustee who has administered upwards of 24,000 bankruptcy cases, I frequently see people who try debt settlement or consolidation and still end up filing bankruptcy. Often when they do, they’ve lost money and their finances are worse than they were in the beginning.

It’s a lot like a patient who goes to urgent care with a broken leg that needs to be reset.  Resetting is scary and hurts, so the patient asks the doctor to simply apply a cast and see how it goes.  A couple of weeks later when the bone is healing wrong, infection has set in, and the pain has increased, the patient returns.  This time the bone must be re-broken, re-set, and antibiotics prescribed.  Only then can the cast be re-applied and the healing begin.  

Dealing with financial distress can be the same.   Filing bankruptcy, like resetting a bone, can be painful in the beginning.  It’s emotionally draining to make the decision and you usually feel a bit like a failure.  You must pay a lawyer. There are the forms to fill out.  Documents to produce.  You must face the questions of a trustee and possibly creditors.  And your credit takes a hit.   But you aren’t a failure.  You are dealing with your situation in a way that the law allows.  And, in time, things will improve.

Once the bankruptcy is filed, the automatic stay will stop creditors from hounding you or garnishing your wages.   The light of a fresh start appears at the end of the tunnel.  If you file chapter 7, the process usually takes a few months.  If you file chapter 13 and repay some of your debts, you’ll make pre-determined payments for 3 to 5 years.  At the end, your debts will be discharged (forgiven) and your credit will improve—after all, you’re now a clean slate.  Additionally, debts discharged in bankruptcy may not result in tax consequences for the debtor, providing an added benefit.   

So, if you find yourself struggling with debt, be sure you consider all your options before you take action.  Consider scheduling a consultation (often free) with a competent bankruptcy attorney.  You can find information here to assist in choosing a lawyer:  https://www.bfine.org/index.php/nine-things-to-look-for-when-picking-a-bankruptcy-lawyer/.

*Dianne C. Kerns has been the Chapter 13 Trustee for Southern Arizona since 1996.  ww.dcktrustee.com.

A public education project of the National Association of Chapter Thirteen Trustees

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